Reset!

I enjoyed a mental reset on Saturday – instead of looking at charts I went to the gym and completely ripped the place up for some much needed stress relief. In the evening I took a hot date to see the new Start Trek movie, which IMNSHO totally kicked ass – and that’s coming from an old Treki.

Today I feel completely refreshed and energized and am really looking forward to Monday. Something many of you might be surprised to hear after last week’s drama and internal tensions. What you should know about me is that I had a fairly tough upbringing as a kid and thus I had the luxury of developing a certain mental fortitude. Having studied martial arts in my life for two decades I’m also more than used to getting knocked on my ass with blood in my mouth. These are the type of moments that define you as a trader – what you do when you just took a big loss despite your best analysis and stringent adherence to managing your capital.

Just like in boxing or martial arts, getting hit is part of the game and you can’t enter the ring expecting to land a knock out punch in the first round and walk away with your nose clean. Just doesn’t work that way. You’ll have to roll with the punches and as the old saying goes in boxing: Everyone has a plan until they get hit :-)

Last Friday was simply the ‘market doing its thing’ – it’s a complete waste of time to ponder about market manipulations and the whys and what. That won’t get you your money back – as I said a few months ago – this market is heavily manipulated and thus if we decide to play we have to abide by rules that guarantee us the best possible odds. In retrospect I violated this mandate by adding on short positions in an obvious bullish Primary consolidation wave anywhere else but at the very peak of the tape. I had dipped into put options at the May 22nd peak and thus suffered all last week getting mentally and financially whipsawed. This is not something you want to be doing in a bear market rally and I only have myself to blame for being led to the wood chipper.

Now – mind you – loading up on lower degree peaks is perfectly fine during confirmed Primary waves to the downside. But trading ‘against the grain’ so to say always has its risks and and to quote myself on several occasions ‘nasty surprises usually happen in the direction of the trend’ – and that dear ladies and leeches right now remains to the upside.

As per this blog, I also decided that it’s time to change the game a little bit. First up, moving forward there will be a zero tolerance policy for haters, spammers, trolls, idiots, drama queens, as well as vapid chitchat. Offending comments will be deleted and repeat offenders will be blocked. This is my house and if you walk in with muddy shoes and throw your weight around you will be dealt with appropriately. Frankly, I simply don’t have the time to engage in some silly Kindergarten feud and my primary concern remains to be my mission to bank coin – for myself of course and for anyone who follows this blog. Anyone who attempts to distract me or any of the long time contributors will be dealt with quickly and mercilessly. Which means I will shoot first and ask questions later. If you don’t like those rules and feel that you are entitled to this or that then please move on and find another place to stink up – we really don’t want you here. I’m not hosting a popularity contest and I am perfectly happy catering to half the audience I’ve been getting if that means I can focus on my trading and maximize everyone’s returns.

In short – there will be a lot less noise in here going forward.

Let’s start with the short term chart first. After Friday’s debable we are now facing two main scenarios:

Soylent Blue: The Friday peak marked the top of Minor X of Intermediate (B) of Primary {2} and we either gap down Monday morning or push a few points higher on Monday which will be followed by a drop to the downside. A breach of 930 will disqualify this scenario and a drop through 880 will confirm it.

Soylent Green: The Friday rally was a break out of a pretty ugly triangle which will be followed by a continued run higher over the next few weeks. The implication here is that we completed a ‘sideways consolidation’ through May and completed Intermediate (X) of Primary {2} on May 28th. A breach of 880 will disqualify this scenario and a push through 930 will confirm it.

As is apparent from both scenario – we are still inside that dreaded 880 – 930 sideways range we’ve been trapped in since late April. Until we do get to those inflection points – are we to take trades in equities at all and if so, when are the best moments to strike?

Let’s assume you buy into Soylent Green and are looking for the best time to load up. The orange box on the chart above around the 907 – 910 range marks a spot where I believe a brief retest of the upper triangle boundary could occur. The beauty of this entry is that a failure would be fairly clear once we break through the 905 – 02 range. So, there’s relatively little risk to be endured (short of holding overnight and being gapped to hell of course).

If we push through 930 and rally higher it’s also possible that there would be a quick retest – again your risk is easily managed around that mark.

However, if you are in the bear camp I would have very little compunction about shorting the market on a continued push to the upside Monday morning – as long as we remain below 924 (the May 20 high) – after that I would be very cautious to play the short side.

Similarly, if we finally breach through 880 then I would not add short positions unless I see a retest of that line. And if that gets breached by more than a few points I would head for the exit quickly. This is probably the only exception to the ‘trade only against the trend at the peak’ rule I mentioned above as my stop would be only a few points away.

For the record – even if I decide to go short again I will be only playing with a few OTM lottery tickets. My rationalization is as follows – if we go down from here it’ll be a substantial move and it’ll probably happen quickly and push Mr. VIX up by quite a bit. If things start running against me this will also prevent me from taking too much of a hit.

I have talked about the ISEE index in the past and the Friday readings are frankly in the stratosphere. Now we all know that the bulltarts require a lot less oxygen to maintain their tiny brain functions and anything is possible these days. But a close above 225 in the ISEE has in the past been a precursor of at least a short term top and was followed by a retracement a few days later. So, it’s very much possible we creep a bit higher Monday or Tuesday and then drop like a rock. So, call me stubborn or stupid but at this point I still give Soylent Blue about roughly 65% of a probability. However, my lines in the sand above stand – should we breach 925 my puts will drop faster than a dress during prom night.

This chart also points towards at least an interim top – we now completed three months to the upside and that has not happened since the end of Cycle wave b completed in October 2007. In terms of percentage gains we have also made a huge amount of progress and rallied 38% since the 667 low. Mmmh – 38% – where have I heard that number before? ;-)

Here’s something fascinating I discovered when I looked at my trusted weekly stochastic chart. First up – the stochs are still pointing down, so we got ourselves a bit of a bearish divergence here. But there’s something else, which I named the ’200 MA Rope-A-Dope’. Again, to lend from traditional boxing terms – this one was coined by the legendary Muhammed Ali – here’s the Wikipedia entry:

The rope-a-dope is performed by a boxer assuming a protected stance, in Ali’s classic pose, lying against the ropes, and allowing his opponent to hit him, in the hope that the opponent will become tired and make mistakes which the boxer can exploit in a counter attack.

In competitive situations other than boxing, rope-a-dope is used to describe strategies in which one party purposely puts itself in what appears to be a losing position, attempting thereby to become the eventual victor.

Now look what happened last time we approached the 200-day MA – we actually dropped short of a touch, thus luring in the bears, and then rallied up again to actually complete the touch. Of course it was all downhill from there and left a lot of hobby bears confused and aggravated (and a few Dollars poorer).

Well, maybe I’m wrong but it seems to me the same game is being played this time around. Sorry for all the allegories but here it goes: ‘Fool me once shame on you – fool me twice shame on me’.

This is what I roughly see in store for us in the longer term. As is apparent from the chart – we remain at an inflection point that will determine the direction of the Intermediate degree trend occupying the next three weeks or so. I know some of you criticize my ‘either we go up or down charts’ – but what you fail to see is that there are trigger points which invalidate one scenario or the other. And getting positioned accordingly right after or ahead of a decision point has resulted in large profits in the past few months.

I have taken the liberties to suggest potential buying/selling opportunities for us in the coming weeks/months. The chart only depicts the direction and approximate pattern of both scenarios as I’m expecting a peak of Primary {2} sometime in August or September. But beyond the direction of the longer term trend it’s also important to know how trade them.

In that context I would like you to read one of my old posts from last year. In essence: Back in June 2008 I speculated that the Dow would drop below $10k and probably further – a lot of people laughed at me back then. This was around the time when I was posting my notorious ‘drop into the abyss charts’ – and they were the reason I got booted off of a certain blog which shall remain unnamed (no, not the Slope), which in turn was the genesis of Evil Speculator. Anyway, as explained in the post – simply buying $4000 worth of Dec08 SPY puts several weeks *before* the peak of Minor 2 of Intermediate (4) of {1} would have banked a trader over $60,000 in profits by November 20th. Had you nailed the top by a few days or so the profits would have been over $100k. The trick would have been to hold all through the noise, the rumors, the short sell ban, the bailouts, etc. – just get those puts and hold them all the way.

This time the stakes are even bigger as this would be a Primary degree wave trade. What I’m looking for is a long term option spread strategy that would beat a vanilla put option purchase *but still benefit from an increase in vega*. Let’s assume we paint a top around August – by my estimation it’ll probably take around 6-7 months to reach the bottom of Intermediate (3) of {3} – which is where I would want to cash out. By then we are also getting dangerously close to hyperinflation and we have to be worried about holding capital in Dollar denominated cash.

Thus, I have sent a ‘code red activation’ to Fujisan who will address the matter in the coming weeks in her ongoing series. I wanted to give her plenty of time to think about this and to plan our strategy. As the old saying goes: Luck favors the prepared mind :-)

Once we get closer to a turning point it will be time to start loading up on long term positions with the expectation to make a killing by early 2010. Let me be very clear about this: Nothing else matters to me at this point and the name of the game on my end is capital preservation. The type of slip up we had to deal with on Friday is unacceptable and will hurt our chances to make a veritable fortune later this year. If I see a high probability trade during the remainder of Primary {2} I will of course take it as described above, but frankly – if it wasn’t for this blog I would probably just take a few weeks off and return late July.

Curly averted a disaster in the mortgage market by going on a spending binge a in the credit markets on Friday as bond yields collapsed – for now. According to Jeff over at the Housing Time Bomb there was massive buying in the MBS and the treasury market. Of course he accomplished that via ‘quantitative easing’ – thus further robbing us of purchasing power in the Dollar (which also dropped below 80 and continues to head lower). Of course Curly is fighting a war he can’t win and as soon as we are touching that diagonal trend line I will be there with ZN puts to play those yields to the upside.

Okay, let’s talk cable. For the noobs – back in the 1800s, Pound Sterling and US Dollars was traded via telegraph cable, so its called cable. Since Fujisan brought up the GBP/JPY I took a look at it and found it even more interesting for the reasons highlighted on the chart. I do like Bollingers when looking at currencies and it seems that the GBP/JPY and the 2.0 BB have a developed a rubberball/wall relationship – every time it breaches the upper band it bounces back almost immediately.

Also, the Dollar has now reached oversold conditions which I do not believe will remain for much longer. Even if this was a third wave to the downside we should expect a fourth wave up fairly soon. If this is the late stage of a C wave then you know what comes next. Thus, I will follow Fujisan into the gates of hell on this one and either play the currency pair down or perhaps go long the FXY.

BTW, in that context check out the symbol M6BM9 – it’s the current front month of the GBP/USD micro futures contract. It was launched on March 23, and complements the design of the current suite of Treasury futures contracts at the exchange. The notional contract size is $200,000, the minimum tick is one-quarter of one thirty-second ($15.625), and it trades on the March quarterly cycle. These contracts trade both open outcry and on the CME Globex electronic platform. TOS offers them btw – here is a list of all new ‘micros’:

Euro/U.S. dollar EUR/USD M6E
British pound/U.S. dollar GBP/USD M6B
Australian/U.S. dollar AUD/USD M6A
U.S. dollar/Japanese yen USD/JPY M6J
U.S. dollar/Swiss franc USD/CHF M6F
U.S./Canadian dollar USD/CAD M6C

ES futures opened a while a go and are now at 918ish – but they haven’t really dropped massively since Friday just yet. I actually would prefer a push higher as opposed to a large drop for obvious reasons.

See you on the other side.

Cheers,

Mole

Diagonal Spreads

Fujisan here.

I like to take this opportunity to say thank you to Mole for all the time and efforts that he has put it in.  I have seen enough negative/hostile comments this week, and negative energy is contagious.  As I said before, 85% of trading is psychological and anyone with negative thoughts are destined to fail.

Taking a loss is a part of the game, and if people cannot handle the loss and mentally affected, they probably shouldn’t have taken the trade in the first place.

Everybody gets what they want from the market.  Negative people get negative thoughts, and positive people get positive thoughts.  That’s all there to it.  Nothing more.

This applies to life in general.  This is not about the market.  It’s all about yourself.  Market is working as a “mirror” to reflect ourselves.  I think this is a very good opportunity for all of us to look into the mirror and see what we got.  This is the reason why 85% of retail traders fail.

Thanks again Mole for leading us, and providing us a timely content and market analysis.  People have no idea what it takes to put up a posting, day in and day out, not just one, but many, every day.  It also takes so much mental toughness to deal with negative thoughts from other people.

Because of you, we are all here.  Especially in the time like this, you deserve so much praises and applauses.  You are doing an amazing job and you are the best!

DIAGONAL SPREADS

OK, moving on to this week’s topic.

I discussed risk management last week and since then, I decided to build up medium-term (a.k.a. more than a couple of weeks) long positions with specific stocks and stay away from shorting the market.  This turned out to be the right decision and I’m very appreciative about this opportunity to make a weekly post.  This is a self-fulfilling process and works quite well to reflect my thoughts.

One of the challenges of building long positions with single stock options is that open interests and strike prices are rather limited and bid-ask spreads are much wider, compared with highly liquid ETFs.  Accordingly, I have to explore different option strategies other than my favorite butterfly and calendar spreads.  I like to use AAPL as an example.

AAPL

Let’s take a look at APPLE.  AAPL is one of a few “confirmed abc up” stocks.  “Confirmed” means the previous high was being taken out with higher volume.  When this happens, there is a 85% probability that the stock will complete 100% abc extension.  I didn’t see this confirmation in GOOG or RIMM but they may go hand in hand as they are the leader of the market at this point.

Now, in this case, the first target (immediate abc extension) is $150 and the 2nd target (the entire wave extension) is $170 with a different timeframe.  How can we play this out with option strategies?

Butterfly

My first pick is my favorite butterfly.  As the first target’s time frame is longer than June OPX, I decided to go with July butterfly instead of June.  This is July 130/150/170 call butterfly.  I will add on Aug butterfly once Aug options become available.

Diagonal Spreads

As I’m looking into multiple months price movement, diagonal may be the best strategy in this case.  Diagonal is a combination of different months and different strike price options.  The way I’m looking at this is that this is a combination of bull call spread and calendar spread.  You go long Oct 130 call options and finance this long position with June 140 call short options.

The beauty of this position is that, you could finance Oct long position with June, July, Aug, and Sep short positions with different strike prices as the underlying stocks continue to move up.

Oct 130 long position is currently priced at $16.90, and June 140 call is $3.20.  Now, imagine, as AAPL goes up, you can sell July, Aug, and Sep calls against Oct 130 calls one after another, and eventually, the cost of Oct 130 calls could be entirely financed through short options while you are riding on the upward movement.

Boxing Out

Do you remember the concept of three and four legged box that I discussed last week?  We can apply the same concept here.  The way it works goes like this:

1.  First, have July 130/150 bull call spread on.


2.  Once AAPL reaches the target area, sell 150/170 Aug bear call spread.  This will create 130/150/170 butterfly.  If you compare this butterfly with the one above, the cost of butterfly is much less and the breakeven points are wider; therefore, better position than the one above.

3. Alternatively, you can add on 150 July puts to 130/150 July bull call spread to create three legged box to ride abc correction after this upside movement is complete.

If you decide to take this position, please wait for a pullback to put the position on.  No reason to put the trade on on Monday.  By all means, please always have a plan.  Set up a stop loss and calculate risk/reward.  Get out of the trade when it goes against you.

SMH

Here is another ETF that is going through multi-months uptrend and yet the open interests are very limited.

If you look at SMH’s open interests, there are in thousands, if not in hundreds, and again, they are not really ideal to set up multi-leg positions.

Here is 20 Aug/21 June call diagonal.  Same logic as AAPL.  You can finance Aug 20 call options with June and July options to reduce the cost of the trade.

I am watching major currency pairs and many of them are at a turning point.  Although the correlation between currency and equity market are becoming very loose recently, I’m expecting some kind of turn around next week and the equity market may well be affected.

EUR/USD has just completed a Gartley pattern and GBP/JPY is also about to turn.  This is not known to many equity traders, but GBP/JPY has the strongest correlation to Dow Jones Industrial Average.  When the market turns, I am planning to load up more long positions so that I could ride the market to the upside through the rest of the summer.  It’s not worth trading against the major trend and the current trend is clearly up.

It’s all up to us to decide what we get out of the market.  Let’s make it a great one!

Have a great weekend.

Fujisan

Sunday Update:

Vidosole brought up very good questions and I decided to address his questions here.  His quesions are followings:

“If we are sure AAPL will continue to go up, why we will complicate the things selling short calls, isn’t it?”

That is very true, and if you like, you could simply buy LEAP options, or buy July 130/150 or Oct 130/150 bull call spreads.  There is no need to make things more complex.  Diagonal inevitably involves an active position management and adjustment.  I prefer to finance long positions as much as possible, and that’s my preference, but if you are new to options and like to take a simple strategy, just buy bull call spreads or LEAP.

“Managing of spread positions is from a crucial importance, and I like very much your view about possible different scenarios developments, and hedging techniques.”

The key here is to be aware of breakeven points in both sides.  I could buy back the shorts once it goes out of the range and adjust my shorts.  As diagonal is a combination of calendar and vertical spread, I adjust diagonal with vertical spread (i.e., buy back 140 and sell 150 call, etc).

If you think Oct/June 130/140 trading range is too narrow, you can have

1. Oct/June 130/150 Diagonal as a start so that you have a wider trading range, or
2. Oct/July 130/150 Diagonal, if you don’t want to worry about an adjustment immediately, or
3. you could simply start with straight Oct long option, and then once long is in the money, add shorts later.

There are many variations that you can work with and we just have to play it by ear.  Looking at the chart one more time, I decided to go with Oct/June 130/150 Diagonal as this target might be hit by June OPX and I don’t want to adjust my position so quickly.

“Fuji, I have a question: How you settle your time frame targets ? What technique you apply to do that?”

I count the number of the candles in a particular wave and I expect the same number of candles to take the next wave up.  So, for instance, if the previous wave has 20 candles, then I expect the same count for the next wave.  I draw a line from lower low to higher high of the previous wave, and make a parallel line to the current wave and see when it hits the higher high of the current wave.  This is called “time and price alignment” where you expect 100% time and price extension.

Fujisan

Sunday 2:05 PST: Mole just pointed out that my wording about correlation b/w currency and equity market is confusing so I am clarifying on this.

I am expecting the following:

1. EUR/USD – Short
2. GBP/JPY – Short
3. US Equity – I expect a pullback but I won’t short it.  I will load up longs once a pullback is complete and ready to go up.

Here is EUR/USD Gartley pattern and a pullback that I’m expecting.

Fucking Friday Rub Down

Alright – this week has taken enough of me – I’m in cash now – obviously:

I had an ominous feeling all day as the Zero Lite was completely flat – an indication that the buyers were waiting for the EOD. As the final hour drew near I kept seeing the tape creep higher and higher but selling pressure was tepid and intermittent at best. We finished the month higher again – third in a row now.

What’s sad about having to exit here is that today was obvious tape painting and I know that we will drop from here sometime next week. However, the EWT rules are quite clear and today sealed the fate on Soylent Blue and brought Green Zombie back to life. Therefore I could not justify holding my already considerable losing position any longer and incur additional theta burn. These are the times when you know that you probably sold somewhere near the top – but you have no choice and have pay your dues. Shit happens – and the bulls played this one beautifully.

Bot Trading Report:

evil.rat/NQ: Short Trade -4, Long Trade + 12.75: Total + 8.75

Alright, forgive me if I bow out now – I’m going to drown myself in a few gallons of Hefeweizen.

That’s right – nothing beats a few Stein of ‘frisch gezapftes Hefeweizen’ and the company of some hot teutonic beauties in their traditional ‘Dirndl’. Yummiee….

Have a nice weekend, rats.

Mole




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